More pain in store for China’s banks

Is a banking crisis brewing in China?
Is a banking crisis brewing in China?

Earnings results from China's big banks over the past week show profit growth slowed in the third quarter, with analysts highlighting rising bad loans as one of the biggest challenges to the sector in the months ahead.

Industrial and Commercial Bank of China, the world's most profitable bank and China's largest, on Wednesday said that its net profit rose 7.6 percent to 67.2 billion yuan ($11.03 billion) in the third quarter, below estimates.

Evidence of a rise in non-performing loans (NPL) among some of the big banks was something to watch for, analysts said.

They added that for the banking sector as a whole the non-performing loan (NPL) ratio has been stable at about 1 percent and some have forecast it higher given the credit boom in recent years.

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ICBC said that its NPL ratio rose to 0.91 percent from 0.87 percent at the end of the first half of the year. Bank of China, the country's fourth biggest lender, also saw its NPL ratio rise to 0.96 percent in the third quarter from 0.93 percent at the end of June.

Mark Ralston | AFP | Getty Images

"I think in 2014 we will see more NPLs, but it will be a gradual process," Mike Werner, senior equity analyst at Stanford C Bernstein, told CNBC Asia's "Squawk Box."

China's banks have pumped huge amounts of credit into the economy since the start of the global financial crisis in 2008. Although that has helped bolster the economy, concern about the credit quality of the loans and the potential for large-scale defaults have fanned worries about the risk of a crisis in China's banking sector.

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"The big question is whether you are going to get a banking crisis – usually for that to occur you need a liquidity event where liquidity dries up and forces the bank to deleverage and that doesn't appear to be on the horizon for the next couple of years," Werner said.

Heading up

May Yan, head of the banking sector for Asia ex-Japan equity research at Barclays in Hong Kong, said that she expected a steeper rise in banks' NPL ratios next year amid a slowing economy and overcapacity in some sectors.

Watch out for risks to China's banks: Barclays
Watch out for risks to China's banks: Barclays

"So far the NPL ratio has been lower than we had expected at around 0.92 percent and we think it will be around 1.38 percent next year, because its seems like the banks are accelerating their efforts to deal with non-performing loans," she said.

"It will eventually impact their credit costs and earnings, but there's unlikely to be a banking crisis because the situation seems manageable," she added. "From an equity perspective, this is a concern because it will impact profit growth."

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Bank of Communications, China's fifth-largest lender, for instance on Wednesday posted a 3.4 percent rise in third-quarter net profit that missed analyst forecasts as margins shrank and non-performing loans rose.

Its return on equity was 13.8 percent for the quarter, its lowest quarterly result since 2006, according to Bernstein Research.

China's number two lender China Construction Bank meanwhile reported its slowest third-quarter earnings growth in more than five years as increased loan-loss provisions hurt its profits.

— By's Dhara Ranasinghe; Follow her on Twitter @DharaCNBC